Indian markets

India Strategy
The Story of THE CHINESE BAMBOO

Nikhil Vora / Nikhil Salvi IDFC Securities Ltd

(Dir) +91-22-6622 2567 / 2566 (M) +91 98211 32471 Email: nikhil.vora@idfc.com / nikhil.salvi@idfc.com
For Private Circulation only. Important disclosures appear at the back of this report

SEBI Registration Nos.: INB23 12914 37, INF23 12914 37, INB01 12914 33, INF01 12914 33.

Indian Markets: The Chinese Bamboo story

Patience is bitter, but its fruit is sweet
- Jean-Jacques Rousseau, Philosopher & Writer The Chinese bamboo tree tests our patience... If you plant the seed of a Chinese bamboo tree, you will have nothing to show for in the first four years just a tiny sampling in spite of your best efforts. Then, sometime in the fifth year, to everyones surprise, the tree sprouts and grows NINETY feet in SIX weeks! In the first four years, the tiny sampling was actually developing its root system underground to sustain its impending overground growth fifth year onwards. If you had uprooted the sampling to see why it was not growing, it would die. But if you were patient and had faith, you would witness the miraculous growth later on. Many a times, Investing in equities is a similar game of patience. But to get the plant, first you need to plant the seed.

It is patently foolish to forget to plant in the spring, take off all summer and then cram in the fall to bring in the harvest Dr. Stephen Covey
The current flurry of announcements by the government reminds us of the farmer who is trying hard to reap in the harvest (last year of the term), when in fact he forgot to plant in the spring (policy inaction in 2nd and 3rd year of the term). The results are not surprising not only is the economic slowdown reflecting in the lag indicators such as GDP growth, but they can worsen further, if the lead indicators are extrapolated. However, in spite of government and regulators making several policy announcements to calm the markets and soothe frayed nerves of investors, we feel the present crop has gone waste and the time has come to be ready for a new season. 1991....2013....same old same old The recent sharp depreciation of INR (worst level of Rs68.8/USD) and declining forex reserves ($276bn as of Sep 27th or 7 months import cover) have evoked faint memories of the Balance of Payment crisis of 1991. The factors leading upto the crisis are similar high structural current deficit (then funded by government borrowing, now by FII flows), inelastic imports, steadily rising fiscal deficit (fiscal profligacy) and delay by government in acknowledging the crisis evoke a sense of dj vu. 1991 : The worst of times....and the best of times Although 1991 was a dark episode in Indias economic history (India forced to pledge gold to borrow), the crisis also forced India to embrace a new economic model. Reluctantly and haltingly, Indian economy opened to rest of the world, domestic business environment changed. In hindsight the turmoil of 1991 laid the foundation for the subsequent India growth story.

Indian Markets: The Chinese Bamboo story

The old economy gave way to emergence of new sectors and new leaders emerged. Unpredictably, sectors like IT and Telecom rapidly emerged, driven by several hitherto undiscovered factors a large, educated, English speaking workforce (IT sector) and the unmet potential demand for easy, instant and affordable communication (Telecom sector). 2013: The worst of (recent) times....can it also be the best? Notwithstanding the fact that current slowdown is partly the handiwork of government inaction, we believe that the reforms of 1991 have had their run and even without policy paralysis of past few years, it would have been difficult to wring incrementally more growth. It is time to introduce India to a new set of ground breaking reforms. The current slowdown has indicated how the government can be pressed into taking the same decisions quickly it would otherwise arrive at after prolonged discourse and delay. Key reforms already underway....expect benefits to materialise in the long term Just like 1991, many of current policy benefits will be visible only in the long run. The Direct Cash Transfer mechanism can potentially reduce wastage of subsidies and hence burden on fiscal budgets, better targeting of beneficiaries and lower leakages in PDS. FDI in multibrand retail can attract much needed foreign capital in long term. Certain actions like the Food Security Bill are only enhanced versions of PDS already in place and may not impact fiscal deficit in as badly as expected. Potentially ground breaking regulations like the Direct Tax Code, which have been chronically delayed by political differences and centre-state disagreements, will also be accelerated in a crisis. We can expect to see the harvest of these seeds in due course in several forms such as controlled fiscal deficit, higher FDI flows, improved tax to GDP ratio, renewed investment cycle, eventually leading to valuation multiples for Indian markets closer to those for developed markets. Crisis or not....some of the seeds for new leaders of tomorrow already sown While not many could have predicted the emergence of new sectors like IT and Telecom in the 1990s, we hazard a guess that the new leaders of tomorrow will be in the consumption space. An increasingly younger demographic, growing up in an indulgence era, will drive growth in sectors like QSR, Liquor and Internet based services. Although currently the opportunities to invest in these segments are limited, we recommend watching out for these sectors as their secular growth overcomes investor scepticism.

Overall, while most investors would seek solace from near term certainty of events, the words of a one-time thought leader to the contrary do merit attention...

Indian Markets: The Chinese Bamboo story

We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten Bill Gates
In the interim, we recommend caution as macroeconomic indicators remain subdued, and non-recurring events like elections will limit room for incremental government action. Under the circumstances, we expect following companies to relatively outperform as their fundamentals help them tide over the near term uncertainties. Top buys Automobiles- Eicher Motors, TVS Motors Infrastructure- JPA, IRB, APSEZ Consumer goods- United Spirits, Jyothy Labs Financials- Axis Bank, HDFC Bank IT Services- Infosys, Tech Mahindra, Persistent Systems Metals- NMDC Oil & Gas- RIL Pharmaceuticals- Dr Reddy's, Cipla, Glenmark, IPCA, Sun Pharma Power Utilities- JPVL, PTC Telecom- Idea Cellular At the same time, we recommend staying away from the following stocks as they look weak structurally Top Sells Automobiles - Tata Motors Cement Ambuja, Ultratech Financials SBI Metals Hindalco Oil & Gas - HPCL

The curious case of Chinese Bamboo

1 2

You take a tiny seed, plant it and water it....you get a tiny sampling...nothing more
You water it, fertilise it.....the sampling stays as it is......nothing happens You continue to water it, take care of it....still nothing happens Against your better judgement, you need to continue to water it, fertilise it.....and still nothing will happen To everyones surprise, the tree sprouts and grows NINETY feet in SIX weeks!

Year

3 4 5

What was going on the first four years?

The tiny sampling was actually developing its root system underground to sustain its impending overground growth fifth year onwards.

The Chinese bamboo tree tests our patience

If you had uprooted the sampling to see why it was not growing, it would die. But if you were patient and had faith, you would witness the miraculous growth later on

Investing - a similar game of Patience

How does the India plant look like

right now?

For seeds of INACTION sown for past few years

Structural problems unaddressed Demand supply gap High CAD

Policy inaction
Fiscal profligacy Near stagnation in decision making

Seeds sown over past two years

High private sector leverage Overambitious overseas expansions

Low growth High inflation Declining forex reserves Excessive leverage crimping equity value High fiscal deficit High CAD Capex slowdown

Harvesting the crop

....now reaping the SLOWDOWN

Equity Index even after 6 years at same levels!

Sensex - gone nowhere in past 6 years!
25,000

20,000

15,000

10,000

5,000

0 11-Sep-07 11-Mar-08

11-Sep-08 11-Mar-09

11-Sep-09 11-Mar-10

11-Sep-10 11-Mar-11

11-Sep-11 11-Mar-12

11-Sep-12 11-Mar-13

11-Sep-13

It is patently foolish to forget to plant in the spring, take off all summer.. and then cram in the fall to bring in the harvest
Dr. Stephen Covey

Government machinery - now in Overdrive

Flurry of government announcements lately o Task force for currency swaps created o Infra announcements
CCI clears 36 infrastructure projects worth Rs1.8trn DMIC clears 6 project worth Rs1.1trn Six airports to be privatised for Rs42.5bn Gas price pooling mulled for starting stalled gas plants

Notification of investor friendly GAAR and some action too Imported coal price issue resolved for power plants SEB restructuring reforms being decisively pushed Coal India directed to sign FSAs by Presidential Directive Parliament functioning relatively better than last time o Better floor management by the government
Key bills passed in monsoon session Food Security Bill, Land Bill, Pension bill

Policy overdrive

Pace of government announcements inversely proportional to falling markets!!

Regulators Now showing their Mettle

o o o Curbs on import of gold purchase on credit, sale of retail investment items like coins, 20% export mandate Streamlining purchase of dollars by OMCs via single bank Easier rebooking of cancelled forex contracts for exporters/importers Allowing MNCs to use dividends from Indian subsidiary to up stake locally Opened FCNR-B mobilization window; Offered swaps to banks at low rates Relaxed trade credit norms for raising funds overseas for import of capital goods by all sectors To introduce inflation indexed retail bonds can divert gold investment demand To issue new bank licenses by Q4FY14 Digitization pushed through across Phase-1 and Phase-2 cities; complete digitization by Dec2014. Recommended reduction in auction rates for 2G spectrum Increased limits for FII investments in Government and Corporate debt Caps on sub-categories of FII debt investments removed

RBI

o o o o o o o o o

TRAI

SEBI

Concerted action by government and regulators will it save the day for Indian markets?

But the Harvest season is not yet over.

PMI indices portend further slowdown in economy Inflation to move up led by food and fuel price increases Election season ahead pause in decision making expected

Currency remains weak

RBI has hiked repo rate for first time in 2 years, signals higher inflation expectation

Possibility of Sovereign ratings downgrade not ruled out entirely

Worsening of macro to continue for some more time

2013.deja vu of 1991?
Evoking comparisonsthen and now
Then.Depletion of Indias forex reservesNow
Forex reserves ($bn - LHS) No. of w eeks of import cover (RHS) 6.0 4.5 3.0 1.5 0.0 14.0
294 8.0 7.0 6.0 5.0 4.0 Jan-13 Mar-13 May-13 Jul-13 300
Total reserves ($ bn) No. of months of import cover (x)

9.0

10.5
288

7.0 3.5 0.0 1987-88 1988-89 1989-90 1990-91

282 276 270

1991

2013

ThenFiscal Deficit increaseing due to fiscal profligacy..Now

Fiscal deficit (%age to GDP) 10.0 8.8 8.8 7.8 7.5 6.4 6.3 5.0 FY80 FY82 FY84 FY86 FY88 FY90 5.9 5.7 6.3 6.6 9.5 8.6 8.2 8.1 8.7

7.0 6.0 5.0 4.0 3.0 2.0 FY05

Fiscal deficit (%age to GDP) 6.5 6 4.9 4.2 4.5 4.0

5.9 4.9

2.5

FY07

FY09

FY11

FY13

Balance of Payment crisis

???

1991the WORST of times

Sharp decline in Indias forex reserves Fiscally expansive government policies (social schemes), leading to bloated budgets Inelastic imports and uncompetitive exports lead to high Current Account Deficit (CAD),
unable to be funded for long

Matters made worse by climb of Crude prices due to geopolitical tension Continuously reducing forex reserves / import cover

Political leadership slow in accepting level of crisis

Only 3 weeks import cover at worst level of forex reserves Fiscal deficit increasing due to fiscal profligacy Forced to pledge physical gold to borrow Forced to accept conditions from international finance bodies

but also the BEST of times!

GDP grow th (%) - tw o decades since reform s 12 9

FDI

FII

Economic growth =income growth

Per capita incom e ($) 4,000 3,000 2,000

50 40 30 20 10 0 -10 -20

Equity markets in a new orbit!

Sensex - up 20x! 25,000 20,000 15,000 10,000

6 3 0

FY91-00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

FY92

FY94

FY96

FY98

FY00

FY02

FY04

FY06

FY08

FY10

5,000

1-Dec-90 1-Dec-92

1-Dec-94 1-Dec-96 1-Dec-98 1-Dec-00 1-Dec-02 1-Dec-04 1-Dec-06 1-Dec-08

Several key reforms undertaken Tariffs and duties progressively lowered

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

GDP growth pushed to higher levels

2013

Attracting large foreign capital

Government relaxed controls on industry

1991
State monopolies broken

Private sector competition encouraged Globalisation embraced gradually Indian markets progressively opened to foreign investors

What was sowed in 1991 reaped over next 2 decades

1-Dec-10 1-Dec-12

1,000

Surprise winners of 1991 reformsnew sectors emerge

Drivers

IT

A large, educated, English speaking workforce Cost competiveness Global Delivery model

Drivers
1991 Reforms

Telecom

Untapped large demand for easy, instant and affordable communication Competition lowered cost of communication Private sector brought aggression and scale to industry

Drivers

Banks

Large scale infrastructure development needed debt funding Overall capex cycle funded by incremental debt New Private sector banks set higher standards of retail service levels, and expanded aggresively

Who will emerge as the winners of current reforms?

While the old economy sectors gave way

Cement.
Cement Mcap as Share of Total Market Cap (%) 5.0 4.0 3.0 2.1 2.0 1.0 0.0 1991 2013 4.7

Capital Goods..
Capital Goods Mcap as Share of Total Market Cap (%) 5.0 4.0 3.0 2.0 1.0 0.0 1991 2013 4.84

2.51

Steel.
Steel Mcap as Share of Total Market Cap (%) 10.0 7.8

Textiles.
15.0 Textiles Mcap as Share of Total Market Cap (%) 14.2

8.0

6.0

10.0

4.0 2.2 2.0

0.0 5.0 1.1

0.0 1991 2013

1991

2013

Markets gave a thumbs up to new India

Quantum change in overall market capitalization
India Market Cap (Rs tn) 80

New winners - IT
IT - Softw are Mcap as Share of Total Market Cap (%) 12 11.6

60

9
40

20

3 0.3

0 1991 1994 1997 2000 2003 2006 2009 2012

0 1991 2013

New winners - Telecom

Telecom Mcap as Share of Total Market Cap (%) 3.0

New winners - Banks

Banks Mcap as Share of Total Market Cap (%) 15.0
2.7

12.4

2.0

10.0

1.0

5.0

0.0 0.0 1991 2013

0.0 1991 2013

But have the reforms of 1991 now run their full course?

2013Is this the WORST of (recent) times???

GDP Decline not yet over.
GDP grow th (%) - visible rapid slow dow n in past tw o years 10.5

IIP In the twilight zoneno clear sense of direction in past 18 months

20.0 15.0 10.0 5.0

9.0

7.5

0.0 -5.0 -10.0

6.0

Jul-09

Jul-10

Jul-11

Jul-12

Jan-09

Jan-10

Jan-11

Jan-12

May-09

May-10

May-11

May-12

Jan-13

4.5 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

PMI Indices indicate contraction in private sector

HSBC Markit PMI Indices - India Manufacturing PMI Services PMI Contraction threshold 60

WPI Inflation set to rise from hereon

(% yoy) 9.0 8.0
56

Wholesale Price Inflation

Both Manufacturing and Services PMIs in contraction mode (first time since Mar '09)

7.0
52 48 44 40 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13

6.0 5.0 4.0 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13

Worsening macros.no end in sight?

May-13

Mar-09

Mar-10

Mar-11

Mar-12

Nov-09

Nov-10

Nov-11

Nov-12

Sep-09

Sep-10

Sep-11

Sep-12

Mar-13

Jul-13

Investment climate has dampened.

New project announcements 48% yoy decline in H1FY14
New announcements (Rs bn) 8,800 6,600 4,400 2,200 0

Both Private and Government new projects on a decline

Private (Rs bn) 6,800 5,100 3,400 1,700 0 Government (Rs bn)

Sep-00

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Sep-13

Sep-00

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Projects under implementation but stalled remain elevated (10% of projects under implementation)
Implementation - stalled (Rs bn) 9,000

Gross Fixed Capital Formation (GCFC) on a decline

GDP Grow th (% yoy) -LHS 12 GCFC- w ith one qtr lag (% yoy) - RHS 24.0 18.0 12.0

6,750

9 6

4,500

6.0
2,250

0.0

0 Sep-99

0 -6.0 Q1FY10 Q3FY10 Q1FY11 Q3FY11 Q1FY12 Q3FY12 Q1FY13 Q3FY13 Q1FY14
Sep-01 Sep-03 Sep-05 Sep-07 Sep-09 Sep-11 Sep-13

India has lost worlds confidence Ratan Tata

Sep-13

But.are these also the BEST of times???

Long term growth seeds being sown Several structural improvements still below radar of analysts
A more disciplined government FMs commitment Fiscal red lines that will not be crossed proven in FY13 Fuel price hikes irreversible Regular diesel price hikes by Rs0.45/lit

Direct Cash Transfer potential to reduce future subsidies substantially

GST and DTCto come sooner than laterno going back FDI in sectors like retail..opposition to FDI slowly ceding ground.can potentially attract large investments

The full impact of these measures will be definitely seen albeit with a lag

Recent fuel price hikes.small..but irreversible

Diesel price hikes now more regular
Diesel prices - Mumbai (Rs/lit) 60
20% 16%

.leading to decline in Diesel demand

Diesel Consumption yoy

55

12% 8%

50

4% 0%

45

-4%

Mar-11

Mar-12

May-11

May-12

Mar-13

May-13

Jul-11

Jul-12

Jan-11

Jan-12

Nov-11

40 Jan-12

Jul-12

Jan-13

Jul-13

Cap on subsidized LPG cylinders reflected in LPG WPI Index

LPG price Index 200

LPG demand growth fallen post cap on subsidised cylinders

LPG Grow th (% yoy) 16% 12%

170 140

8% 4% 0%

110 80 Jan-08

-4%

Jul-11

Jul-12

Mar-11

Mar-12

May-11

May-12

Mar-13

Jan-11

Jan-12

Jan-13

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

As consumers are unshielded from international price changes, fuel demand to moderate and hence fuel subsidies to reduce

May-13

Nov-11

Nov-12

Sep-11

Sep-12

Jul-13

-8%

Nov-12

Sep-11

Sep-12

Jan-13

Jul-13

-8%

Direct Cash Transfer.inflationary.but necessary

Cash in lieu of benefits Deposited directly to bank account

DCT contours
UID linkage to identify beneficiaries

Direct transfer of food and fertilizer subsidies in cash to targeted beneficiaries has the potential to save almost Rs600bn, without any major adverse impact on the beneficiaries
- Commission for Agricultural Costs and Prices

Gradual scaleup of schemes and geographies

Kerosene demand decline even before DCT in place

Potential impact on subsidies

Study by TERI and IISD indicates saving of Rs41bn or 17% of kerosene subsidy every year

Kerosene Grow th 5% 0% -5% -10% -15%

Jul-11

Jul-12

Jan-11

Jan-12

May-11

May-12

Jan-13

With UID and bank account linked DCT, subsidies will be targeted to beneficiaries

May-13

Mar-11

Mar-12

Nov-11

Nov-12

Sep-11

Sep-12

Mar-13

Jul-13

-20%

DTC and GST.substantial ground gained

Direct Tax Code (DTC)
To overhaul the Income Tax Act Rationalisation of taxation Process of rolling out the DTC is already under way Draft prepared from extensive stakeholder consultations currently being examined by various Ministries Both the Centre and the State to basically and fundamentally change the overall structure of tax assignment Rs90bn set apart as the first instalment of the balance of central sales tax (CST) compensation to states Cabinet to introduce the bill in Parliament

Goods and Services Tax (GST)

A single or fewer rates for both goods and services to replace the multiple taxes being levied Redistributing the burden of taxation equitably between manufacturing and services Rationalisation of taxation Draft prepared from extensive stakeholder consultations currently being examined by various Ministries Both the Centre and the State to basically and fundamentally change the overall structure of tax assignment

Potential impact on

Potential impact on

tax collections
To widen tax collection base Tax/GDP ratio to increase substantially from ~11% currently

economy
GDP growth estimated to be up by 1% with the implementation of a well-designed GST.

10%+ increase in exports estimated

The impact of DTC and GST will materially plug taxation loopholes

Few more seeds.that will bear fruit in due course

FDI in Multi-brand retail
Gradual opening of sector can potentially bring in large scale investments

Large scale Infra investments on cards

CCI clears 36 infrastructure projects worth Rs1.8trn DMIC clears 6 project worth Rs1.1trn 6 airports to be bided out for Rs42.5bn

Digitization
Structural change in television sector Phase - 1 & 2 successfully completed Goldman invested $110m in DEN Networks More FDI to follow

FDI in Aviation
Tata group announced two JVs one with Air Asia and Singapore Airline Jet Etihad deal underway

Real Estate Bill

Will bring one of Indias largest grey industry under regulation

New bank licenses

To improve reach of banking sector in unbanked areas expanding financial inclusion net

These relatively smaller steps will contribute to increasing the investibility of Indian markets

FDI in retail - potentially one of largest FDI in India

Size of Indian Retail to grow to $1.25tn by 2020

Retail

FDI in

Size of Organised Retail from 6% to 20% or $260bn, but will be still far less than developed economies (80%+) India is the 5th most favorable destination for international retailers India can attract upto $15bn in FDI in the next five years

The China Retail FDI Case

China has attracted $30bn+ of FDI in retail even with gradual opening of sector
China first permitted FDI in retail in 1992 with foreign ownership restricted to 49% Over 600 hypermarkets opened since Employment in the retail and wholesale sectors doubled to 54m in two decades since 1992

FDI in aviationthe next one to follow

Jet Etihad deal : $379m for 24% stake Tata Air Asia JV announced

Aviation

FDI in

Tata Singapore Airlines JV: To launch full service carrier in India SpiceJet in advanced talks with Emirates / Tiger Air for stake sale

The seeds are being sown, but is the ground fertile?

The fertile ground - India is in an Indulgence Age

I can SPEND INCOME effect I am WILLING TO SPEND MORE MINDSET change I know WHERE TO SPEND AWARENESS levels In spite of slowdown, still one of worlds top growing countries 35% of Indians born in post liberalization Increased media proliferation Increased brand options in each of the business segment India moving up the value chain premiumization Peer influence reflected in consumption choices

I have OPTIONS TO SPEND AVAILABILITY

I WANT MORE THAN I NEED ASPIRATION effect There are MORE like me BROADBASED growth

India to be USD1trillion consumption opportunity by 2015-16

Changing Consumer
India, amongst the youngest age profile 600m+ people below the age of 25 years

170m+ working women

Women account for 1/4th of workforce in India

Increased consumer durable ownership

Increased spends on consumer durables, home furniture, etc

Savvy and informed kids influencer in decision making

361m of India in age group below 15 (6x USA)

We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten
Bill Gates

Who will be the winners of next decade

QSR The best play on food retail in India

Indian Food Service Industry Size

The Indian food services Industry is now a US$12.5bn Industry! Expected to grow to US$23bn by 2015! The organised share, currently at 30%, is expected to move to 45% by 2015! This translates into a 40% CAGR over the next 3 years for the organised sector! An increasing youth demographic and expanding urbanisation will drive growth for the organised sector
Format wise breakup
Caf and Parlours Pubs and Bars 3% 4% Food Courts 8% Bakery 9% Kiosks Institutional 4% Catering 1% QSR 33%

(Rs bn) 800

Unorganised

Organised

600

400

200

0 2010 2011 2012 2013E 2014E 2015E

Quick Service Restaurants are the largest piece of organized market; having 1/3rd share Over the next 3 years, QSR industry is expected to DOUBLE to over US$2.5bn We believe businesses with strong brands, healthy cash flows and scalable models like Jubilant Foodworks and Westlife Development are likely to provide disproportionate returns to investors in the long term.

Fine Dining 14% Casual Dining 24%

Source: Indian Restaurant Report, 2012

Digitization. will the disparity remain?

Globally, three of the top 10 value creators in Media are standalone distribution companies!!!

140

160

24 12 Indian TV distribution industry

C&S homes (m) EV (US$ bn)

Comcast largest cable company in US

India, world's 2nd largest C&S market (US at 140m homes) valued at 1/12th

a single player in US!

Liquorequations to reverse?
Alcohol vs Tobacco MCap: India to revert to global norms
Worldwide
- Alcohol companies have higher market cap than tobacco companies However, in India Alcohol companies have had significantly lower market cap so far Such mismatch to global norm is expected to correct going forward

M-Cap of Tobacco vs Alcohol companies Globally and in India

(US$ bn) 1,000 Tobacco Brewers & Distellers (US$ bn) Tobacco Brewers & Distellers

50

750

Global Brewers & Distellers at 1.4x Mcap of Tobacco cos

860

40 42 30

Alcohol cos at 1/5th Mcap of Tobacco cos

500

601 20

250

10 9

0 Global

0 India

36

The wild card: Indias digital demographic

Indias demographic so far only seen as workforce and consumers Need to relook the demographic in digital terms
A predominantly young populace being introduced to digital devices at an increasingly early age) Deep mobile penetration (66% of population) High mobile internet usage (25% of mobile users) Internet usage skewed towards mobile (at 143m, mobile internet users are 10x broadband internet users) The worlds 2nd largest populated country having only 16% internet penetration vs Chinas 43% and 80% in US

India can potentially give rise to one of the worlds largest online digital markets

What is Indias digital generation consuming?

Others 38% Social Networking 25%

1/4th of time current spent on networking

Retail 2% News/Information 2% e-mail Business/Finance 8% Search/Navigation 3% 3% Source: comScore report June 2012 Portals 9%

Entertainment 10%

75% < 35 years

25% >35 years

3/4th of Indias online users are below 35 years of age

Source: comScore report June 2012

Online retailing: equal opportunity for Indian players

Amazon unable to replicate success of USA overseas
Japans online market size $128bn Top online retailer is local company Rakuten with 26% market share Brazils online market size $17bn Amazon only recent entrant and only in e-books

Chinas online market size $110bn Amazon, even after 9 years in China, is not among top 5

Indias online market $12bn 4th largest number of online shoppers in Asia Competition from ever increasing number of Indian online shopping sites!

Source: www.emarketer.com

An

executive cant compete with an entrepreneur !!!

Virtual explosion of online shopping sites in India

The list will only keep on increasing.

.And so will the options available to investors

QSR
Jubilant Foodworks Westlife (McDonalds)

DIGITISATION

DEN

Hathway

LIQUOR

United Spirits

Radico Khaitan

INTERNET

Just Dial

expect many more names in the public markets in coming years

What will India reap in future the next decade!

GDP growth pushed to higher levels 7-9% once more

Tax to GDP ratio increases

India Current Account Surplus!

Indian markets to trade at higher PE multiples near developed markets

Fiscal deficit reduced to 2% of GDP!

FDI Inflows increase to $70-80bn annually Several key reforms undertaken

Demand Supply structural issues addressed inflation below 3%!

2023

Internationalization of INR

2013
Fiscal deficit contained
GST roll out FDI limits raised for several sectors

Renewed focus on infrastructure

Direct Cash Transfer roll out

DTC implementation

What we are sowing todaywill be reaped in the future!

Till thenwe recommend to tread cautiously

Model Portfolio Sector
Automobiles Construction/Infra/Power Equipment Consumer goods Financials IT Services Metals Oil & Gas Pharmaceuticals Power Utilities Telecom Others Total 100

Sensex weight (%)

10.1 4.7 15.3 23 17.5 5.2 13.3 6 2.6 2.3

Mar-13 weight
8.5 6 15 23 12 5 13 9 3 1.5 4 100

Sep-13 weight
9 5 15 20 18 3 11 10 3 3 3 100

Top ideas
Eicher Motors, TVS Motors JPA, IRB, APSEZ United Spirits, Jyothy Labs Axis Bank, HDFC Bank Infosys, Tech Mahindra, Persistent Systems NMDC RIL Dr Reddy's, Cipla, Glenmark, IPCA, Sun Pharma JPVL, PTC Idea Cellular AIA Engineering, United Phosphorus

Current macroeconomic environment discourages riskier bets in the near term

Top Picks and Financials

(based on FY15 Estimates)

Top buys Large Cap

Large cap (Mcap>US$2bn)
Large cap (Mcap>US$2bn) Price (Rs) Adani Port & SEZ Reliance Industries Cipla 145 844 440 Mcap (Rs bn) 290 2,760 354 FY15 EPS (Rs/share) 11 80 24 Earnings CAGR FY13-15E 20.0 11.7 12.7 P/E (x) 12.7 10.6 18.3 EV/EBITDA (x) 9.5 7.2 10.5 P/BV (x) 2.7 1.3 2.9 RoE (%) 23.3 12.5 16.8 RoCE (%) 13.4 10.3 19.3

Companies

Dr Reddy's Lab
Glenmark Pharma Idea Cellular Infosys NMDC Sun Pharma Tech Mahindra United Spirits

2,386
571 174 3,022 123 605 1,443 2,461

404
155 573 1,726 488 1,252 178 310

129
33 6 208 16 25 140 40

16.8
20.1 39.7 12.2 (1.0) 20.0 23.9 73.6

18.5
17.4 27.8 14.5 7.8 24.2 10.3 62.1

12.0
12.1 7.0 9.0 3.8 16.9 5.3 26.3

3.9
3.6 3.2 3.1 1.5 5.3 2.5 4.3

22.9
22.8 12.0 23.2 19.9 24.6 26.9 7.1

19.6
20.9 11.7 26.6 21.9 29.6 28.0 9.6 RoA (%)

Axis Bank HDFC Bank

1,072 634

440 1,475

156 46

15.1 26.9

6.9 13.8

1.2 3.0

1.1 2.9

17.8 23.1

1.7 2.0

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top buys Mid and Small Cap

Mid cap (Mcap between US$2bn and US$500m)
Mid cap (Mcap<US$2bn and >$0.5bn)

Companies Eicher Motors IPCA Laboratories Jaiprakash Associates Jaiprakash Power

Price (Rs) 3,780 704 38 16

Mcap (Rs bn) 102 88 80 42

FY15 EPS (Rs/share) 256 45 7 3

Earnings CAGR FY13-15E 46.5 33.0 79.2 58.1

P/E (x) 14.8 15.5 5.6 5.4

EV/EBITDA (x) 7.6 10.2 6.2 6.0

P/BV (x) 2.5 3.6 0.4 0.6

RoE (%) 18.9 26.2 8.0 11.5

RoCE (%) 25.8 27.6 10.2 10.2

Small cap (Mcap < US$500m)

Small cap (Mcap<$0.5bn)

Companies

Price (Rs)

Mcap (Rs bn) 33 26 29 28 15 21

FY15 EPS (Rs/share) 28 14 10 78 5 8

Earnings CAGR FY13-15E 12.9 (5.3) 60.3 29.0 10.0 33.8

P/E (x) 12.2 5.5 17.9 8.8 9.7 5.6

EV/EBITDA (x) 7.3 6.7 14.3 4.0 (1.8) 3.5

P/BV (x) 1.8 0.7 3.6 1.9 0.6 1.3

RoE (%) 15.6 12.5 21.6 23.7 6.4 24.9

RoCE (%) 19.7 10.1 16.0 29.7 8.4 23.4

AIAE IRB Infra Jyothy Laboratories Persistent Systems PTC TVS Motor

348 78 179 689 51 45

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top sells
Companies Price (Rs) Ambuja Cement Hindalco Industries HPCL Tata Motors 193 122 193 348 Mcap (Rs bn) 294 233 65 1,109 FY15 EPS (Rs/share) 11 14 42 36 Earnings CAGR FY13-15E 4.0 (5.9) 152.2 5.0 P/E (x) 17.8 8.7 4.5 9.6 EV/EBITDA (x) 10.3 7.1 12.3 4.5 P/BV (x) 2.9 0.6 0.4 1.9 RoE (%) 16.9 6.7 9.8 21.7 RoCE (%) 18.1 7.3 3.0 19.8

UltraTech Cement

1,905

522

106

4.4

18.0

10.2

2.6

15.4

15.0
RoA (%)

State Bank of India

1,633

1,037

228

5.2

7.2

1.2

0.9

13.6

0.8

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Alcoholic beverages
United Spirits: BUY

Diageo to transform United Spirits with operational control: With the acquisition of 25% stake in USL, Diageo now has operational control of USL. Diageos acquisition of USL is poised to underpin a strong transition towards portfolio premiumization. Pernod Ricard generates Rs5.9bn+ of PAT selling 24m cases in India, indicating the inherent profitability in the industry. With USL drawing 70% of its volumes from mass segment brands, profitability in the business has remained subdued (EBITDA/case 1/4th that of Pernod Ricard India). This is clearly up for a critical change as Diageo re-instates focus towards premiumization and value rather than volume. Indian liquor industry dynamics set to change: With Diageo and Pernod Ricard, the two largest global players, now controlling 60%+ of the Indian spirits market, we sense a potent change in the operating dynamics of the industry. With profits and best practices being the key focus for Diageo and Pernod, we believe terms of the trade will improve significantly and bring to fore the inherent profit generation capability of the industry. USL set to become one of the top Indian Consumer Stocks: As Diageo focuses on premiumization, profitability in the business is poised to see a significant increase. Even if Diageo were to contract USLs volumes by ~30% (to 90m cases), the business would still have a profit potential of over US$350m. Further, with balance sheet deleveraging (already underway repaid Rs16bn of debt in Q1FY14), USLs profitability is expected to improve significantly. We expect USL to become one of the biggest names in the Indian consumer space in the long run on the lines of an ITC or Hindustan Unilever (with potential inclusion in Indias benchmark index Nifty).
Price (Rs) MCap (Rs bn) 310
7th

Companies

EPS (Rs/share) 39.6

Earnings CAGR (%) FY13-15E 73.6

P/E (x) 62.1

EV/EBITDA (x) 26.3

P/BV (x) 4.3

RoE (%) 7.1

RoCE (%) 9.6

Target Price (Rs) 3,000

Reco

United Spirits

2,461

OP

Note: Financials based on FY15 Estimates; Price as on

October 2013

Top Buy/Sell
Automobiles
Eicher Motors: BUY
Structural play on leisure biking (63% of EPS) and market share gain in MHCVs. Market share in MHCVs up 270bp in CY12 in a weak market and sans a captive financing arm; increasing customer and financier acceptance Offers superior growth visibility in a cyclical industry due to rising HCV market share (up in a weak market), resilient LMD and exports/outsourcing. RE deserves to trade at 20x (PEG of 0.25x); at this target PEG its cheaper than the Indian 2W names even with a superior business model. Dealer checks suggest RE can achieve volumes of 175,000/250,000 in CY13/CY14 as capacity expands. Trading at 14.8x CY14E EPS with a EPS CAGR of 46% . Structural pick with TP of Rs4,355

TVS Motor: BUY

5 launches to make it a full portfolio player. Aid market share and margin expansion. Deal with BMW to aid diversification and boost premium segment presence. 31% reduction in Indonesia operating losses to Rs350m in FY13 despite a 19% volume decline a key positive Deleveraging to boost non-operating growth as Interest-bearing debt of Rs4bn (25% of mkt cap) to be retired by end-FY14. Sold windmill business to Green Infra. (TVS investment was at Rs767m with debt of Rs2.6bn) Best risk-reward as stock trading at 5.6x FY15E, BUY with TP of Rs58

Top Buy/Sell
Automobiles
Tata Motors: SELL
JLR - competitive intensity on the rise against JLRs two new models (upgrades apart) in four years; competition plans to introduce 18 models. Risk to Streets 15% volume growth assumption in FY15. Evoque in its prime; growth onus on Jaguar: Base affect and competition (4 all-new launches, including Porsche Macan & BMW X4) catching up with Evoque. Growth onus on Jaguar which will be margin dilutive. JLR valuations unreasonable: Premium valuations for JLR (40% higher EV/sales than BMW) unjustified given, a) capex-led uncertain free cash flows; b) rising dependence on Jaguar, and c) intense competition. Structural weakness of standalone business cant be ignored (c.25% of SOTP target price of Rs261) Recommend selling on every rally.

Top Buy/Sell
Automobiles
Companies Price (Rs) Top Buys Eicher Motors TVS Motor Top Sells Tata Motors 348 1,109 36.4 5.0 9.6 4.5 1.9 21.7 19.8 261 UP 3,780 45 102 21 256.0 8.0 46.5 33.8 14.8 5.6 7.6 3.5 2.5 1.3 18.9 24.9 25.8 23.4 4,355 58 OP OP MCap (Rs bn) EPS (Rs/share) Earnings CAGR (%) FY13-15E P/E (x) EV/EBITDA (x) P/BV (x) RoE (%) RoCE (%) Target Price (Rs) Reco

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Cement
Ambuja Cement / Ultratech: SELL

Revival in cement demand to be muted - lack of large infrastructure projects and industrial activity driving weak demand No improvement in utilisation levels as incremental supply exceeds incremental demand Cost pressures sustain: weak rupee to offset benefits of lower international coal prices, higher freight costs (15% increase in rail haulage from 1st Oct0 EBITDA/t to at best remain flat over FY13-15 led by muted volumes and lower realisations Valuations extremely expensive at 10-11x EV/EBITDA and 17-18x FY15 PER leaving no room for earnings disappointment. Any downside to earnings will de-rate stocks and drive significant underperformance
Earnings CAGR (%) FY13-15E

Companies

Price (Rs)

MCap (Rs bn)

EPS (Rs/share)

P/E (x)

EV/EBITDA (x)

P/BV (x)

RoE (%)

RoCE (%)

Target Price (Rs)

Reco

Top Sells Ambuja Cement UltraTech Cement 193 1,905 294 522 10.8 105.6 4.0 4.4 17.8 18.0 10.3 10.2 2.9 2.6 16.9 15.4 18.1 15.0 165 1,650 UP UP

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Consumer Goods
Jyothy Lab: BUY

From a limited opportunity play: Limited opportunity play (USD500m)in only 3 mass-end categories and one flagship brand Ujala and skin to GCPL in 2008 GCPL in 2008 had limited product portfolio (low growth visibility); Promoter-driven business for past 30 years, without professional management To a whole new scale!!: Post the Henkel acquisition, market opportunity up 10x to US$5bn in India; Entry into premium categories Henkel infuses a premium brand- width into a hitherto mass market portfolio. Management bandwidth scaled up.. Business integration complete: Spearheading the change in management is new CEO Mr S Raghunandan, a turnaround veteran. The new team, brought in by new CEO, has 15-25 years of experience from across the top consumer names like HUL, Marico, Colgate, Paras, Sara Lee etc. Re-organisation of management team as well as the realignment and integration of the two businesses (Jyothy and Henkel) is complete with the first signs being visible in a blockbuster Q1FY14 result Poised to enter the big league: JYL can potentially be another Godrej Consumer Products, which has grown over the last 5 years through acquiring successfully and has increased market cap by10x in the process

Top Buy/Sell
Consumer Goods
Companies Price MCap EPS Earnings CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco

(Rs)
Top Buys Jyothy Laboratories 179

(Rs bn)

(Rs/share)

FY13-15E

(x)

(x)

(x)

(%)

(%)

Price (Rs)

29

10.0

60.3

17.9

14.3

3.6

21.6

16.0

250

OP

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Engineering
AIA Engineering: BUY

Deeper penetration in international mining segment driving volume growth with 75% of revenues from replacement demand Margins likely to bottom out in FY13 and improve in FY14 by 100bps led by 1) improved revenue mix towards liners within mining segment b) price increases with mining customers and 3) lower forex losses in FY14 Plans to expand capacity by 100,000 tonnes over the next 2 years to tap growth in mining segment Upside to earnings estimates Trading at 12.2x FY15E earnings at the lower end of its historical trading band considering sustainable growth (13% CAGR in earnings over FY13-15), superior return ratios (20% RoCE) and oligopolistic nature of industry.
Price (Rs) MCap (Rs bn) EPS (Rs/share) Earnings CAGR (%) FY13-15E P/E (x) EV/EBITDA (x) P/BV (x) RoE (%) RoCE (%) Target Price (Rs) Reco

Companies

Top Buys AIAE 348 33 28.5 12.9 12.2 7.3 1.8 15.6 19.7 400 OP

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Financials
Axis Bank: BUY

Under valued deposit franchise Axis has evolved into a strong retail deposit franchise and we believe it is undervalued. Market cap to total deposits and market cap to CASA deposits 45% lower than private banks average Strong low cost deposit franchise 42% CASA is a significant advantage in such tight liquidity environment. We expect Axis to remain amongst the better CASA franchises medium term Healthy net interest margins Axiss NIMs are over 350 bps, NIMs likely to remain strong led by high CASA ratio, increasing exposure to retail segment. Above industry loan growth Axis should continue to grow its loan book at above industry levels while loan growth in corporate segment has moderated, ample room to drive growth in retail/SME segment Stable credit costs - We believe credit costs are likely to remain stable between 90-100bps over the medium term. We do not expect a sharp jump in credit costs near term. Healthy return profile/high capital cushion Axis has a healthy ROE of 17-18% over FY14-15E. Moreover, with recent capital raising, Axis has reasonably high capital adequacy of 12.25% Valuations well below historical means - Current valuations are attractive at 1.2 FY15E P/Adj. BV and 6.9x FY15E P/E. We believe the stock will provide healthy returns over the medium term Key risks sharp deterioration in the SME asset quality and broader economic slowdown

Top Buy/Sell
Financials
HDFC Bank: BUY

A strong retail deposit franchise- HDFC Bank is the one of the best deposit franchises in the current environment with CASA ratio of ~45% Healthy net interest margins HDFC Banks NIMs remain one of the highest in industry (over 400bps) and boasts of the lowest cost of funds. Offers significant cushion in current tight liquidity environment Steady , above industry loan growth HDFC Bank continues to growth ahead of industry with 20%+ loan growth. We believe HDFC Bank will continue to grow at healthy levels led by retail segment . Lowest credit costs, strong asset quality HDFC Bank has the lowest credit costs in the sector (~80bps) and coverage levels are well above 100%. With Gross NPAs at 1.1%, HDFC Bank has performed significantly well on the asset quality front. We rule out any significant rise in credit costs for HDFC Bank. Consistent, predictable earnings performance HDFC Bank has demonstrated the most consistent earnings growth even in difficult times. With return ratios of 21%+ for FY14E we believe the stock offers strong returns with reasonable safety Will continue to trade a premium valuations HDFC Bank has traded at a significant premium to its peers given its superior asset quality, consistent performance and steady RoEs. We believe current correction in the stock (trading 3x FY15E P/Adj. BV and 13.8x FY15E P/E) offers an attractive entry point . Key risks sharp deterioration in the retail asset quality and broader economic slowdown

Top Buy/Sell
Financials
State Bank of India: SELL

Asset quality under pressure - Asset quality has continued to weaken for SBI it now has amongst the highest NPLs in the sector (at 5.6%) and a long restructuring pipeline. We do not see signs of improvements near term, given continued stress in the mid-corporate and SME segments key areas of weakness for SBI

Credit costs likely to remain high We believe SBIs credit costs will remain high medium term as it needs to provide more to shore up the low loan loss coverage on existing NPLs (50% coverage), slippages from restructured assets and further NPL creation ahead.
Top management change ahead SBIs top management team is set to see a complete overhaul in the next 18 months as the entire top management team achieves retirement age. We believe this can lead to a significant transition period for the bank.

Declining NIMs SBI is witnessing a decline in NIMs over the past 5 quarters. Moreover, the bank has consciously decided to focus on low yielding corporate/retail loans. We believe, SBIs NIMs will remain stressed notwithstanding its strong deposit franchise given declining loan yields and significant interest reversals.
Low capital cushion SBIs Tier-I capital adequacy ratio at 8.8% is relatively lower than most large private banks in the country. Likely further dilution will continue to remain an overhang on the stock in near term. Stress adjusted valuations not cheap SBI is trading at 1.2x FY15E P/Adj BV and at a significant premium to other PSU banks (in line with some large private banks). Given the higher asset quality pains there is significant room for downsides. Key positive strong deposit franchise for the bank in an uncertain funding environment can lead to the bank garnering significant market share

Top Buy/Sell
Financials
Companies Price (Rs) Top Buys HDFC Bank Axis Bank Top Sells State Bank of India 1,633 1,037 228.0 5.2 7.2 1.2 0.9 13.6 0.8 1,545 UP 634 1,072 1,475 440 45.8 155.8 26.9 15.1 13.8 6.9 3.0 1.2 2.9 1.1 23.1 17.8 2.1 1.7 745 1,580 OP OP MCap (Rs bn) EPS (Rs/share) Earnings CAGR (%) FY13-15E P/E (x) P/Adj. BV (x) P/BV (x) RoE (%) RoA (%) Target Price (Rs) Reco

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
IT Services
INFOSYS: BUY
Return of NRN Murthy to catalyze the growth engine Management is aggressively investing in business correcting under-investment of FY09-11 The focus has shifted to driving revenue growth instead of a myopic focus on margins Improved large deal traction is expected to lead to convergence of revenue growth with peers

Enough headroom in margin levers SG&A leverage, utilization, consulting mix and INR weakness to be key margin tailwinds. Utilization at 71-72% for IT services vs. optimal band of 78-80% gives enough headroom

Indian IT services yet not ex-growth Indian IT exports can still grow at 12-14% for few years beyond FY14 Draft US Immigration Bill could be a near-term drag on growth as players re-align their businesses

Valuation discount to narrow Change in business prospects with a macro uptick to narrow valuation discount vis--vis TCS.

Key risks: a) continued sluggishness in global IT spend environment; b) pricing pressure in plain vanilla IT services

Top Buy/Sell
IT Services
Tech Mahindra: BUY
Healthy execution/ merger to drive steady growth Growth to be led by a) non-BT telecom business, b) non-Telecom verticals, c) acquisitions Merged entity (stronger balance sheet and scale of business) well placed to compete for large deal wins

Margins to remain in a narrow band Low hanging margin levers have been utilized INR weakness and Employee pyramid (~30% in 0-3yrs experience vs. ~50% for larger peers) would be key drivers

Visibility on BT business remains bleak but, relatively less important post merger Few large BT contracts due for renewal in FY14/15; Post merger, BT share at ~12% Non-BT Telecom and Non-Telecom piece showing healthy traction 10+ deals with 3 large deals in Q1

Gradual re-rating to continue on improved prospects and better growth visibility TechM currently trades at ~10x FY15E EPS (vs. 14-20x for larger peers)

Key risks: a) Weakness in global macro environment; b) pricing pressure in plain vanilla IT services; c) risk of aggressive acquisitions

Top Buy/Sell
IT Services
Persistent Systems: BUY
Bets on right technologies Persistent was ahead of peers to invest into right technologies Cloud, Mobility, Analytics and Social/ Collaboration SMAC has been a major area of investment across industry verticals and a driver of discretionary spend IP revenues are growing faster than company on the back of organic and inorganic efforts With gross margin of 50%+ in IP revenues, we see margins sustaining at high levels for the Company PSYS trades at ~8.8x FY15E EPS in-line with peer avg. and estimated EPS CAGR of 29% over FY13-15E With IP share sustaining above 20% of revenues, we see PSYS commanding premium over other small mid cap peers

Focus on IP revenues to drive growth, margins

Valuation not inexpensive; We expect further re-rating as IP mix increases

Key risks: a) Slowdown in capex cycle of global technology companies; b) aggressive acquisition in IP space
Price (Rs) MCap (Rs bn) EPS (Rs/share) Earnings CAGR (%) FY13-15E P/E (x) EV/EBITDA (x) P/BV (x) RoE (%) RoCE (%) Target Price (Rs) Reco

Companies

Top Buys Infosys Technologies Persistent Systems Tech Mahindra 3,022 689 1,443 1,726 28 178
7th

207.7 78.0 139.9

October 2013

12.2 29.0 23.9

14.5 8.8 10.3

9.0 4.0 5.3

3.1 1.9 2.5

23.2 23.7 26.9

26.6 29.7 28.0

3,500 850 1,750

OP OP OP

Note: Financials based on FY15 Estimates; Price as on

Top Buy/Sell
Infrastructure
Jaiprakash Associates: BUY
Ramp up in cement volumes and cash flows. Expect demand recovery in H2 led by good monsoons and pre-election demand surge EBIDTA to improve to Rs900/ton led by better pricing and volumes; to improve cash flows substantially

Debt refinancing complete in JIL Repayment period extended upto 18 years Positive for the real estate business and for the stock

Expect improved cash flows from commissioning of key assets Bina power plant commissioned; Nigrie nearing completion Coal production commenced in Amelia North

Deferred development of Rs200bn Lower Siang hydro project postpones equity dilution beyond FY15

Divestment of Gujarat cement plant complete

To reduce Rs38bn in consolidated debt Further divestments on the cards in the infra and power businesses

Focus on third party E&C business (hydro power) to cushion EPC profits Valuations attractive at PE of 5.5x FY15E. SOTP based price target of Rs89/share.

Top Buy/Sell
Infrastructure
IRB Infrastructure: BUY
Balanced mix of operating and under construction assets Cash generation gives ability to fund equity in new project Execution of EPC orders gives growth in earnings

Assets part of trunk national highways and offer strong growth potential
Moderate leverage, superior returns and strong cash flows key differentiators vis--vis peers D/E of 2.2x as against 3-5x for most peers Debt/EBIDTA of 4.1x vis--vis 5-19x for peers Rs14bn cash flow over 2 years (post debt-repayment)

Backward integration, own equipment and control over raw materials drive higher EPC margins Valuations attractive at 2.9x FY14 cash earnings and 6.7x EV/EBIDTA on FY15 basis Factor concerns on low IRRs on its recent projects Adequate margin of safety

Key risk unfavorable outcome of ongoing investigation by the CBI on promoters/company officials

Top Buy/Sell
Infrastructure
Adani Port & SEZ : BUY
Strong visibility on cargo Long term contracts for coal and crude cargo at Mundra; rising market share in container cargo Incremental cargo from commissioning of Hazira and Dahej Ports to add to volumes

Strong earnings profile Expect 21% CAGR in earnings over FY13-15; Driver will be strong growth in cargo at various assets Initial losses from newer assets to peak in FY14 Return profile to improve expect 450bp improvement in RoCE

Leverage ratios to peak at current levels Capex intensity across assets to come down Improved free cash generation to reduce leverage to 0.6x by FY15E from 1.7x in FY13

Valuations attractive 12.7x consolidated FY15 earnings and 9.5x EV/EBIDTA Earnings dont fully reflect Strategic value of SEZ land bank High entry barriers in the business protect medium-long term returns in the business DCF based fair value of Rs185 provides strong upside potential

Top Buy/Sell
Infrastructure
Companies Price
(Rs) Top Buys Adani Port & SEZ 145 290 11.4 20.0 12.7 9.5 2.7 23.3 13.4 185 OP

MCap
(Rs bn)

EPS
(Rs/share)

Earnings CAGR (%) FY13-15E

P/E
(x)

EV/EBITDA
(x)

P/BV
(x)

RoE
(%)

RoCE
(%)

Target
Price (Rs)

Reco

IRB Infra
Jaiprakash Associates

78
38

26
80

14.1
6.8

(5.3)
79.2

5.5
5.6

6.7
6.2

0.7
0.4

12.5
8.0

10.1
10.2

147
89

OP
OP

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Metals
NMDC: BUY

Volume growth on track

Opening of new deposits (Deposit 11-B) and ramp-up of existing operations (Kumaraswamy) to aid volume growth story. We expect sales volume to grow at a 9% CAGR over FY13-15E. Any positive development on rebuilding of slurry pipeline of Essar will aid to volume growth

Pricing power to improve over the medium term

While near term realization has been under pressure on declining international prices and lower demand from domestic sponge iron players, we expect a prices (especially for fines) to increase over medium term Given that NMDC is the only large player outside Orrisa, any supply constraint on adverse regulatory news flow will improve overall pricing power

Higher dividend payout; Strong balance sheet health

NMDC has a net cash of Rs53/share (~46% of current market cap), which is expected to increase to Rs62/share by FY15 (53.3% of current market cap). Higher dividend payout of Rs7/share in FY13, makes NMDC a ~6% dividend yield stock (at CMP). We expect higher payout to continue, as company is expected to generate positive FCF, despite a capex of Rs3bn p.a in steel plant.

Key risks: a) lower international iron ore prices b) delays in ramp-up of Deposit 11-B and Kumaraswamy

Top Buy/Sell
Metals
Hindalco: SELL

Domestic aluminum - volume growth on track but margins a concern

We expect a base case RoCE of 5% for Mahan project, given (a) delays at Utkal refinery (b) lack of captive coal till FY16 (c) cost escalations at Mahan smelter and Utkal refinery Declining linkage availably and lower LME Aluminum prices to result in declining EBIT margins for existing operations ( as evident from a 956bps yoy decline in FY13 EBIT margins which came at 10.6%)

Benefits of volume growth at Novelis some time away

Novelis recently guided for a flat to lower yoy EBITDA in FY14, despite 5-10% volume growth

Narrowing LME-Scrap spread, as evident from recent contracts in North America which were signed at lower conversion premiums

Rising leverage our biggest concern

Rising capex intensity and lower operating cash flows (both at standalone aluminum operations and Novelis) has resulted in a Rs130bn rise in net debt to Rs457bn (Mar-13). We expect net debt to further rise to Rs503bn by FY14 (Adj. net gearing of 2x).

Key risks: a) higher LME prices b) improving recycling spreads resulting in margin expansion at Novelis c) a faster than expected ramp-up of Mahan coal block

Top Buy/Sell
Metals
Companies Price (Rs) Top Buys NMDC Top Sell Hindalco Industries 122 233 14.0 (5.9) 8.7 7.1 0.6 6.7 7.3 85 UP 123 488 15.7 (1.0) 7.8 3.8 1.5 19.9 21.9 140 OP MCap (Rs bn) EPS (Rs/share) Earnings CAGR (%) FY13-15E P/E (x) EV/EBITDA (x) P/BV (x) RoE (%) RoCE (%) Target Price (Rs) Reco

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Oil & Gas
RIL: BUY

Material downstream expansion to add US$130bn to consolidated EBITDA by FY16E, growth of ~45% over FY13 levels Upstream segment a relatively minor portion of value; further negative news flow or surprises/delays in gas price hike unlikely to affect value by more than Rs40-50/sh (<5% of our TP) We believe that refining margins unlikely to moderate too much from here, pace of capacity additions is faltering which should help keep complex margins elevated Current valuations factor in pessimism on upstream without looking at long term benefits from US$12bn downstream expansion, which should drive a 11% CAGR in earnings over FY14-16E and reverse slide in return ratios

HPCL: SELL

Heavily dependant on subsidies to report profits; even a 15-20% yoy reduction in gross subsidies over FY14E -does not change this dependence Operationally the worst among the three OMCs, with GRMs of US$2.58/bbl in the quarter, more than 35% lower than BPCL No other segment to hedge against subsidy burden unlike BPCL (upstream) and IOCL (petchem) EV/E based TP of Rs186/sh, implying EV/E of 9.8x FY14E

Top Buy/Sell
Oil & Gas
Companies Price (Rs) Top Buys Reliance Industries Top Sell HPCL 193 65 42.5 152.2 4.5 12.3 0.4 9.8 3.0 186 UP 844 2,760 79.7 11.7 10.6 7.2 1.3 12.5 10.3 1,013 OP MCap (Rs bn) EPS (Rs/share) Earnings CAGR (%) FY13-15E P/E (x) EV/EBITDA (x) P/BV (x) RoE (%) RoCE (%) Target Price (Rs) Reco

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Pharmaceuticals
Dr. Reddys Labs : BUY

DRL is one of the most competent players in the US generics market with a proven track record of commercializing complex generics like Isotretenoin, Fondaparinux, Tacrolimus, Metoprolol Succinate, Lansoprazole, Omeprazole OTC etc over the last three years and a strong pipeline.

A slew of recent launches (e.g. Zenatane, gDacogen, gAzacitidine, gReclast and gZometa (potential sales of US$150m in FY14) has allayed concerns over FY14 growth. Likely deferral of niche launches to FY14 should improve FY14 US business growth contrary to earlier expectations. 31 products in DRLs portfolio are ranked among the top 3 in terms of market share (IMS Aug-12). DRL filed two ANDAs in Q1FY14. Sixty-four ANDAs are awaiting USFDA approval, of which 38 are Para IVs and eight have FTF status. DRL has built up an enviable DMF filing portfolio over the past 3-4 years indicative of future portfolio.

DRLs focus on stepping up R&D and filing high-value and complex products like gCapoxone is positive DRL is the only pharma player which has not reflected weaker currency gains in FY13 earnings due to aggressive hedging; If INR stays at current levels, DRL could realize at least Rs57-58/$ in FY14. This can substantially prop up earnings over the next few quarters. While Q1 disappointed, we see recovery in PSAI and scale-up of recent niche US launches. At CMP , the stock trades at ~18x FY15E, a sharp discount to most large peers. Also, given the return ratios of >20% and a net-cash balance sheet, valuations remain attractive DRL remains our top pick in the Indian pharma space.

Top Buy/Sell
Pharmaceuticals
Cipla : BUY

FY13 is an inflection point in Ciplas growth trajectory with a change of guard at the top management (Dr Hamied stepping down from MD role and new CEO taking executive control) after a series of senior-level hirings over the last couple of years While the management has not been vocal about the contours of these changes, Ciplas focus on revitalizing business and enhancing profitability has begun delivering returns. The ~$512m proposed acquisition of Cipla Medpro underlines this new aggressive growth mindset. With ~16% CAGR over CY11-16E (IMS), EMs will be the primary driver of global generics. Ciplas focus/ presence in EMs (~80% of FY15E sales; including India) and management efforts to enhance control over the distributor-driven EM business model, we believe Cipla is the best placed Indian company to play the EM opportunity. Further rationalization of low-margin business, increased focus on profitability, stress on balance sheet improvement, willingness to look at front-ends, and emphasis on lateral hiring stands out among the companys growth strategies. Cipla reported strong Q1FY14 revenue growth given new pricing policy and strike in Maharashtra and Q1FY13 had exclusivity profits, we remain positive on the potential of Ciplas evolving business model. While a strong EM footprint should provide a growth anchor, Ciplas relatively smaller US / EU businesses can deliver material upside as R&D capabilities get leveraged in niche spaces. Expect healthy double-digit revenue growth in FY14 on an organic basis, driven by multiple factors like scale-up in the EU front-end business, approvals of a couple of niche opportunities in the US etc. Building in CMP consolidation, a weak rupee and the new pricing policy, we expect 12% CAGR (19% CAGR over FY12-15) in Ciplas earnings over FY13-15E. At ~18x FY15E earnings, valuations appear attractive. Maintain Outperformer with a price target of Rs480 (20x FY15E EPS)

Top Buy/Sell
Pharmaceuticals
Glenmark Pharma : BUY

After effectively addressing investor concerns on balance sheet issues, Glenmarks strong FY13 operating performance (36% yoy EBITDA growth) and guidance of 20% yoy growth in FY14 is reflective of the potential of its generics business model We expect profitability to steadily improve hereon as investments in growth begin to pay off across geographies led by the US and India

In the US, we expect the niche pipeline to drive steady growth (11 OCs, 19 dermatology products already approved, another 7-8 awaiting approval); FTFs will continue to provide further upside In India, Glenmark remains among the fastest growing top-20 players and will continue to post double-digit growth In the RoW markets, Glenmark is leveraging niche therapies in dermatology, respiratory and oncology to drive growth (37% growth in FY13); Latam is also set for a turnaround

Expected scale-up of ROCE to 19-20% (despite Rs1.7bn-1.8bn of NCE R&D spend) over FY13-15E (from 11-12% over FY09-11) builds a strong case for re-rating of the generic business Further, significantly value-accretive newsflow on the NCE pipeline possible over next 12-18 months

Adjusted for NCE R&D spend, Glenmarks generics business trades at effective valuations of ~17x FY15E with >20% return ratios for FY15E; the stock is trading at a discount to peers.

Top Buy/Sell
Pharmaceuticals
Ipca Labs : BUY

A competitive mid-cap business with superior API capabilities and a scalable, diversified global formulations business. The company has grown 17%/ 34% CAGR in terms of revenue/ PAT over FY09-13. With Indore SEZ getting USFDA approval and strong ANDA pipeline and sustainable UK business recovery, Ipca is set to embark on the next phase of growth. Ipca has filed 35 ANDAs, and has received 15 approvals and commercialized eight products.

The company seeks to deploy a higher proportion of cashflows into R&D (spend almost doubled in FY13; e.g. initiation of a 505(b)(2) project in FY13); so the quality of growth should improve further.
Domestic business grew ~12% in Q1FY14 despite implementation of new pricing policy; we expect 16% growth in FY14 as restructuring initiatives have stabilized and productivity starts to improve. Ipca has gained market share in key therapies like pain management and cardiology. Given Ipcas significant net foreign exposure, currency tailwinds would accelerate earnings momentum; it has hedged ~26% of its net foreign exchange earnings (NFE) for FY14 at an exchange rate of Rs58/$. FY15 NFE could be ~$300m If INR stays ~60/share; gains could be meaningful. Limited competition, low-cost inventory and likely approval of new products will help expand the companys institutional malaria business. Revenue potential of Rs7-8bn over the next five years. At ~15x FY15E PE, Ipca is our top mid-cap pick in the space.

Top Buy/Sell
Pharmaceuticals
Sun Pharma: BUY

Sun has established a strong medium-term growth platform for all its three core generic business segments. It is now working to evolve into a global specialty pharma company

Suns move to acquire DUSA, a niche dermatology business, marks its foray into the high-potential branded drugs space in the US

Sun remains one of the most competent players in the domestic business; slowly creating a solid business in RoW by replicating the India template

Taro: Taro had had a dream run before 4QFY13 with several quarters of price-led growth, but the management has been sounding a note of caution. We estimate Taros revenues and profits to decline over FY14-15.

US business: Sun (including Taro) has filed 453 ANDAs (adjusting for dropped filings), received 320 approvals and is awaiting approvals for 133 products (including niche products like Astelin nasal spray). Likely one of the largest Para IV portfolios The company sees limited impact of the new pricing policy in the domestic segment; the worst-case impact is Rs400m-500m While near-term upsides could be limited given the recent upmove, we recommend buying into weakness. Reiterate Outperformer. Key risk to our call: Sharp deterioration in profitability contribution from Lipidox and Doxycycline.

Top Buy/Sell
Pharmaceuticals
Companies Price (Rs) Top Buys Cipla Dr Reddy's Lab Glenmark Pharma IPCA Laboratories Sun Pharma 440 2,386 571 704 605 354 404 155 88 1,252 24.0 129.0 32.7 45.4 25.0 12.7 16.8 20.1 33.0 20.0 18.3 18.5 17.4 15.5 24.2 10.5 12.0 12.1 10.2 16.9 2.9 3.9 3.6 3.6 5.3 16.8 22.9 22.8 26.2 24.6 19.3 19.6 20.9 27.6 29.6 480 2,451 605 772 580 OP OP OP OP OP MCap (Rs bn) EPS (Rs/share) Earnings CAGR (%) FY13-15E P/E (x) EV/EBITDA (x) P/BV (x) RoE (%) RoCE (%) Target Price (Rs) Reco

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Power Utilities
Jaiprakash Power Ventures: BUY

High Fuel Security

Operational hydropower capacity of 1,700MW; Vishnuprayag affected by floods - earning risk in near term limited by insurance and PPA provisions Coal linkage for 500MW of Bina Thermal Power Station and 1980MW of Bara Thermal Power Station Coal blocks linked to upcoming Nigrie Thermal Power Station have received all the clearances; Amelia (North) to start production in September 2013 and Dongri Tal II in 4QFY14. Immediate funding concerns obviated with Raising of Rs9.5bn from QIP in February 2013 Rs10bn as a corporate loan - sufficient to meet immediate debt and equity commitments Further, we expect additional funds to be raised through securitization of operating power plants to meet debt and equity commitments Commissioning of 500MW at Bina Thermal Power Station Commissioning of 1.3GW at Nigrie Thermal Power Station in FY14

Fund raising eases funding concerns

Earnings to grow at 30%CAGR over FY13-FY15E

Valuations attractive at PE of ~5x FY15E and P/BV of 0.6xFY15E SOTP based price target of Rs41/share

Top Buy/Sell
Power Utilities
PTC: BUY

Trading volumes should remain strong

26% CAGR growth in trading volume over FY13-FY15E Long term capacity of ~ 1.4GW and ~6.6GW expected to commence operation in FY14 and FY15 respectively Resolution of dispute with Karcham to aid ~2.5BU L1 bidder in UP , Rajasthan and Tamil Nadu bids Renegotiation of tolling arrangement into trading arrangement ( a part of upside from better tariff will be captured) High cost of supply from these power plants @Rs4.90/unit No fuel price risk and foreign exchange risk on PTC India UP DISCOM financial restructuring to help in payment TN dues have reduced to Rs2.8bn expect to be paid entirely by December Hence , yield on cash and working capital should improve; thereby boosting earnings Aided by availability of power from long term PPAs Tolling arrangement was attractive in near term

No tolling price risk

Receivables from UP and TN are reducing

Standalone Earnings to grow at 10%CAGR over FY13-FY15E

Valuations at PE of 9.7x FY15E and P/BV of 0.6xFY15E SOTP based price target of Rs58share

Top Buy/Sell
Power Utilities
Companies Price (Rs) Top Buys Jaiprakash Power PTC 16 51 42 15 3.0 5.2 58.1 10.0 5.4 9.7 6.0 (1.8) 0.6 0.6 11.5 6.4 10.2 8.4 41 58 OP OP MCap (Rs bn) EPS (Rs/share) Earnings CAGR (%) FY13-15E P/E (x) EV/EBITDA (x) P/BV (x) RoE (%) RoCE (%) Target Price (Rs) Reco

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

Top Buy/Sell
Telecom
Idea Cellular: BUY
Prospects for Indian wireless sector set to improve Competition has been rational - focus on profitable growth, partial/ full exit of fringe players and prudent participation in spectrum auctions Regulatory environment is improving at the margin with authorities focused on catalyzing industry growth Idea Cellular is a pure play on India wireless Idea derives 90%+ revenues/ Enterprise value from the India wireless business ~2% uptick in realization potentially drives ~5% increase in EPS (2-3% in case of Bharti Airtel) Most attractive asset in India wireless Pan India footprint with top3 presence in 50% of the service areas Fastest growing player with meaningful revenue market share of 16%+ and strong brand positioning Relative valuation premium to sustain Market share gains and improving profitability to drive healthy EPS growth (39% CAGR FY13-15E) Strong execution and market share gains to support premium valuation and drive stock performance Key risks: a) renewed competitive vigor post Reliance JIO entry, b) cancellation of 3G roaming pacts

Companies

Price (Rs)

MCap (Rs bn) 573

EPS (Rs/share) 6.2

Earnings CAGR (%)

FY13-15E 39.7

P/E (x) 27.8

EV/EBITDA (x) 7.0

P/BV (x) 3.2

RoE (%) 12.0

RoCE (%) 11.7

Target Price (Rs) 200

Reco

Idea Cellular

174

OP

Note: Financials based on FY15 Estimates; Price as on 7th October 2013

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Analyst
Shirish Rane Nikhil Vora Prakash Joshi Nitin Agarwal Hitesh Shah, CFA Manish Chowdhary Bhoomika Nair Pramod Kumar Ashish Shah Abhishek Gupta Mohit Kumar, CFA Param Desai Probal Sen Swati Nangalia Saumil Mehta Harit Kapoor Sameer Bhise Nikhil Salvi Jay Kale, CFA Dharmendra Sahu Equity Sales/Dealing Tapasije Mishra Anish Damania Vishal Purohit Ashish Kalra Rajesh Makharia Kalpesh Parekh Varun Saboo Tanvi Dixit Chandan Asrani Samir Gilani Mukesh Chaturvedi Viren Sompura Rajashekhar Hiremath IDFC Securities US Ravilochan Pola Sanjay Panicker

Sector/Industry/Coverage
Co-Head of Research; Construction, Power Co-Head of Research; Strategy, FMCG, Media, Retail, Education, Mid-caps Oil & Gas, Metals, Mining Pharmaceuticals, Real Estate, Agri-inputs IT Services & Telecom Financials Engineering, Cement, Power Equipment, Logistics Automobiles, Auto ancillaries Construction, Power Telecom, IT services Construction, Power Pharmaceuticals, Real Estate, Agri-inputs Oil & Gas Media, Alcoholic beverages, Education, Exchanges, Mid-caps Metals, Mining FMCG, Retail, Paints, Mid-caps Financials Strategy, Mid-caps Automobiles, Auto ancillaries Database Analyst Designation Group CEO Head Institutional Equities Head of Sales Managing Director, Sales Director, Sales Director, Sales VP, Sales AVP, Sales Manager, Sales Head of Trading Director, Sales trading SVP, Sales trading SVP, Sales trading Designation CEO Director

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November 2012

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